Self-managed superannuation funds (SMSFs) incur several different types of expenses over the course of an income year. Self-managed superannuation funds (SMSFs) incur several different types of expenses over the course of an income year. Some of these expenses are deductible against the fund’s income, with most only deductible in part, usually based on the extent to which the expense was incurred in producing assessable income. However, while some expenses may only be partially deductible, there are other expenses that will always be fully deductible no matter the situation of the Fund.
Expenses of an SMSF can be deductible under several different sections of the relevant legislation, the Income Tax Assessment Act 1997 (ITAA 1997), depending on their type. As a general rule, expenses are deductible under Section 8-1 to the extent that they were incurred in the earning of assessable income, unless a specific deduction applies. Expenses which are deductible under Section 8-1 are known as general expenses.
One method of determining the deductibility of these general expenses is by using the actuarial method of 1 minus the actuarial exempt income proportion. This percentage is provided on the Accurium actuarial certificate and will also take in to account any segregated assets during the year to provide an accurate deduction for any general expenses relating to the full year.
Another method of deducting these general expenses is to use the ‘income ratio method’ provided in Tax Ruling 93/17:
assessable income x actuary’s exempt income proportion + NCC + CC + rollovers
assessable income + NCC + CC + rollovers
(NB: NCC = non-concessional contributions, CC = concessional contributions)
This method is more complicated than using the actuarial method, but can provide a greater deduction if there are contributions or rollovers during the income year.
Fund operating expenses such as management or audit fees are examples of general expenses that need to be apportioned. ASIC fees for corporate trustees also fall into this category
When considering the deductibility of expenses under Section 8-1 it is also possible for expenses to be fully deductible rather than needing to be apportioned. Some expenses may not be deductible at all. If an expense solely relates to the earning of assessable income it will be fully deductible. Conversely, if the expense relates solely to earning exempt income it will be fully non-deductible, these are known as ‘distinct and severable expenses’.
While general expenses are only deductible to the extent that they relate to earning assessable income there are certain expenses which are always fully deductible, no matter the exemption of the fund.
Fully deductible expenses
A common example of expenses which do not fall under Section 8-1 and are not required to be apportioned are those relating to a fund’s tax affairs. Under Section 25-5 of the ITAA 1997 eligible expenses incurred in managing a fund’s tax affairs or complying with a Commonwealth tax law obligation on the trustee are fully deductible. Costs relating to the preparation and lodgement of the SMSF annual return are an example of expenses which are fully deductible under Section 25-5.
Another expense which falls under Section 25-5 is the cost of the actuarial certificate. While the actuary’s exempt income proportion is used to determine the deductibility of general expenses the cost of the certificate itself is always fully deductible to the fund.
The SMSF supervisory levy and certain legal expenses can also be covered by specific deduction provisions (i.e. section 25-5 or others), with any legal expenses not covered by a specific provision usually falling under the general deduction provision.
While being fully deductible does make it easy to determine the total deductions available for tax related expenses, care should be taken to ensure expenses are correctly classified to ensure the fund is not under or over claiming deductions. It should also be remembered that it is not possible to deduct capital expenditure under Section 8-1. Costs associated with establishing a trust or executing a new trust deed for example are classed as capital in nature and are non-deductible. However, general updates to trust deeds to do with the ongoing operations of the fund could be classed as a general expense.
Section 4 and 5 of Tax Ruling 93/17 also provides some guidance on which expenses are fully tax deductible.
The Sunny Day Superannuation Fund had two members and a mix of retirement phase and non-retirement phase balances during the 2019 income year. As an unsegregated fund an actuarial certificate is obtained in order to claim Exempt Current Pension Income (ECPI), with the Fund’s exempt income proportion being 65.27%.
After obtaining the tax exemption and determining the exempt income it is then time to work out the expense deductions available.
The trustee determines that there are total expenses of $5,600. Of the total expenses; $800 was specifically incurred in producing assessable income, $600 was specifically incurred in producing exempt income, $950 was for tax related expenses, including the actuarial certificate, and the remaining costs are general expenses. It is decided that the actuarial method will be used to claim the general expenses.
To calculate the general expense deduction the total expenses ($5,600) are reduced by the distinct and severable expense ($800 and $600) and by expenses deductible under Section 25-5 ($950). The remaining general expenses ($3,250) are then multiplied by the general expense deductibility proportion under the actuarial method (34.73%).
($5,600 - $800 - $600 - $950) x .3473 = $1,129
The end result is that $1,129 of the general expenses are deductible, as well as the total of the distinct and severable expenses related to earning assessable income and the expenses which are always fully deductible under section 25-5 of $800 and $950 respectively. This gives the fund a total deduction of $2,879.
While ECPI is likely to be the largest deduction available to an SMSF this does not mean that the other available deductions are inconsequential. Only partially claiming a deduction on expenses which should instead be fully deductible, no matter how small, can build up over the years, resulting in a material impact on a fund’s balance.
Further information on expense deductibility can be found on the ATO website here.